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Getting Green and Staying Green

Avoiding the High Hidden Costs of Noncompliance

EU RoHS, China RoHS, Korea RoHS, California RoHS, ELV, REACH – the list of environmental regulations for reducing hazardous substances in products keeps growing. What, exactly, are the costs if your products fail to comply? Missed customer requirements, blocked shipments, costly redesigns, and scrapped parts are just the tip of the iceberg. No doubt, the stakes are high, with potentially millions of dollars in lost revenue and related costs.

To avoid these costs, manufacturers
must identify, track, and control a constantly
evolving list of high-risk substances,
both in their products and in
their supply chain. Spreadsheets, homegrown
databases, and manual processes
simply can’t meet this enormous data
management challenge.

When a manufacturer is compelled to
preemptively remove a product from the
market, potential revenue is lost. In the
time it takes to introduce a new compliant
product, the company may also lose
market share. Even after a new replacement
product is introduced, ongoing
operating costs may increase, especially
if the company must manage two versions
of the same product – one that is
compliant and one that is not. In each of
these cases, no fines are levied, but the
cost of noncompliance is significant.

Manufacturers, particularly those
attempting to address compliance for
the first time, tend to underestimate the
true costs of noncompliance. As a result,
compliance programs may not receive
sufficient commitment from senior management.
Compliance initiatives may be
neglected, delayed, or if undertaken,
result in inadequate solutions, which can
expose the company to a significant risk.

The first step in mitigating these risks
is to fully understand all the costs of failure
in each of nine broad categories –
costs that will be unique to your company
and products.

Modeling the Failure Scenario

The total cost associated with a compliance
failure can be modeled by looking
at the cash flows generated by a product
over its lifetime (see Figure 1). The
upper curve represents the typical product
cash flow. At first, cash flows are negative
as the company invests in design
and development. Cash flows turn positive
as the product goes into production.
Cash flows decline slightly as the product
matures, and decline sharply when it is
retired. The lower curve shows what happens
when there is a compliance failure.
The area between the two curves represents
the total cost to the company due
to this compliance failure.

The total cost of compliance failure
will depend on many factors including
where in the product’s lifecycle the fail ure occurs and what corrective action
the company takes. The company may
decide to simply retire the product. It
may decide to halt shipment and later
introduce a compliant version of the
product. In some cases, the company
may be forced to rework or replace units
that have already been shipped. One
high-tech company took this approach
in 2001 after Dutch authorities determined
that its product contained cadmium
levels that exceeded the limits set by
Dutch regulations. This particular company
took action on several fronts,
including reworking units in inventory
and replacing units that had already
shipped. At the time, the estimated total
cost of the failure, including rework, was
110 million Euros in sales and 52 million
Euros in profits.

Quantifying the Nine Components of Cost

There are typically nine cost components
associated with an environmental
compliance failure. These costs fall into
three main categories: lost revenue,
short-term crisis mode costs, and longterm
capability building costs.

Lost Revenue

Cost #1: Lost Revenue - Short-Term. A
compliance failure will likely lead to a
period of time in which the product is
taken off the market – perhaps several
months. This means immediate, shortterm
lost revenue. In addition, if the
product is early in its lifecycle, the window
of opportunity in which the product
may have 100% market share – and
therefore greater pricing power and
higher margins – is reduced.
Cost #2: Lost Revenue – Long-Term. A
late or interrupted product launch due
to a compliance failure will have a longterm
revenue impact as well. The total
sales life of the product will be shorter. In
addition, a late introduction may mean a
missed opportunity to lock in buyers if
there is a transition cost associated with
the product. Long-term lost market
share is generally never regained. Finally,
a late introduction may have a lasting
effect on profit margins since the delay
opens the door for competitors to
reduce the manufacturing learning
curve ahead of the company.

Short-Term Crisis-Mode Costs

Cost #3: Fines and Fees. Fines and fees
are one-time costs. These are perhaps
the most obvious costs associated with
compliance failure, but actually may represent
the smallest contributor to overall
costs. Additional costs may include regulatory
fines, customer penalties and
other fees, including those arising from
lawsuits and public relations services.

Cost #4: Design, Requalification, and
Test. Fixing a noncompliant product is
seldom a trivial task and may involve a
significant redesign effort. For example,
transitioning from a noncompliant to a
compliant electrical component may
require a new printed circuit board layout.
All the costs associated with a new
design should be considered, such as
retooling, requalification, and reliability
testing of all new components and
assemblies.

Cost #5: Address Units in the Field.
Fixing or replacing units that are already
in the field presents numerous challenges
and costs. The company must
decide whether to rework or scrap these
units. The company may decide to
replace units at the customer site with
reworked units. All shipping costs must
be included here. Finally, original equipment
manufacturers (OEMs) typically
cannot sell refurbished units as fullpriced
units, which represents one more
cost to be considered.

Cost #6: Address Units in Inventory.
Another set of decisions and costs is
associated with the units in inventory.
The company may decide to scrap or
redirect noncompliant components or
sub-assemblies for use in other products
or markets. The company will also have
to transition existing suppliers, or identify
and ramp up new ones. If both compliant
and noncompliant parts will be
held in inventory for a period of time,
there will be an increase in overall inventory
holding costs. On the product side,
the company may decide to temporarily
deliver two versions of the product to
market – one that is compliant and one
that is not. This will increase inventory
and other operational costs.

Cost #7: Data Collection, Doc -
umentation, and Reporting. A key component
of regulations such as REACH
and RoHS is that the company must
track and ensure product compliance
internally, and ultimately provide evidence
that the product is compliant.
This verification involves collecting the
relevant material content data from all
suppliers and performing the required
analysis and documentation at the product
level. The cost of this effort will
increase if internal and external supply
chain members need to be educated
about what data needs to be collected
and how it is to be reported. If the product
involves many components and suppliers — for example, some large OEMs must account for hundreds
of thousands or even millions of supplier parts and their
specifications — the effort and cost here is considerable.

Cost #8: Process and Organization – Short-Term. While dealing
with the crisis, the company will likely need to change its
way of doing business. The amount of change required will vary,
but some corrective action must be taken. For example, teams
and processes may need to be established to fill gaps in the current
supplier declaration, collection, validation, and documentation
process. These costs may be increased because the company
will generally be operating in crisis mode, which generates
expediting costs, higher labor costs, redundancies, and errors,
as employees and the supply chain learn the new processes.

Long-Term Capability-Building Cost

Cost #9: Process and Organization – Long-Term. Lastly, it
should be noted that Cost #8 concerns only building the minimal
capability required to fix the immediate crisis. These
processes will generally be manual and focused on a single
design team and one operational group. They may be focused
on just one regulation or just a single set of restricted substances.
The company may eventually decide to incur additional
costs such as building long-term, enterprise-wide capabilities
to prevent additional compliance failures in the future. These
costs will include building new business processes and systems
around product design, manufacturing, supplier data collection,
and supply chain assurance.

Avoiding These Costs

The scenario shown in Figure 1 depicts a single-failure event;
for example, a product blocked from shipment because it has
been found to contain a restricted substance. An event like this
is usually an indicator of bigger problems with an organization’s
processes and systems for managing compliance and
risk. These problems will likely lead to more failures over time,
although they may involve different products and different
restricted substances, regulations, or customer requirements.

In an effort to avoid the costs of failure, many companies
have made the mistake of taking an event-driven approach
focused on a single failure point; for example, one restricted
substance, one customer requirement, or one regulation such
as RoHS. This reactive approach is apparently low cost, but
actually leads to much greater costs down the road as new,
more restrictive regulations like REACH emerge.

Consider two companies: Company A builds capabilities to
address long-term risks arising from current and horizon regulations
and customer requirements. Company B, in contrast,
focuses exclusively on addressing the current failure event. The
relative costs of each approach – proactive and reactive – are
illustrated in Figure 2. As shown in the figure, Company A, by
taking a proactive approach, incurs an initial cost. Company B,
meanwhile, takes a reactive approach and incurs a series of
recurring costs, the sum of which is much greater than that
incurred by Company A. In this way, the “low-cost” approach
actually becomes the higher-cost approach.

Adopting a Long-Term Strategy

As companies establish priorities, weigh alternatives, and
plan an approach to addressing REACH, RoHS, and similar
environmental regulations, they must take into account all of
their potential costs, including those related to lost revenue.
Similarly, they must account for all potential sources of risk,
including those related to horizon regulations and customer
requirements.

Failure to understand all the costs and risks associated with
the challenge may lead to shortsighted and risky solutions. For
example, companies that have invested considerable time and
effort building processes, systems, and databases tailored to the
six RoHS-restricted substances may now be unprepared to
track and manage the new and growing list of REACH SVHC
(substances of very high concern).

The key to succeeding and avoiding costs in this new, constantly
evolving regulatory environment is a scalable and proactive
approach tailored to the unique needs and risks of your
business. It’s vital to invest in building processes and systems that
support this long-term approach before an actual crisis occurs.
The long-term costs of being unprepared are simply too high.

This article was written by Andrew Wertkin, Vice President, InSight
Products and Technology, at PTC, Needham, MA. For more information,
visit http://info.hotims.com/22928-121.

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